Earlier in the week we looked at Lowry Research and found them to be continuing to be bullish based on their proprietary measures of demand and supply for equities. In fact, their Buying Power index has surpassed its April highs, indicating that there is a much underlying strength in the equities market.
Checking in with Ned Davis Research, another major technical firm, we find them arriving at similar conclusions. As you may recall, NDR has been “maximum overweight” equities since June 2009. This buy signal (of sorts) from NDR was earlier than the August 2009 one from Lowry. And now, just like Lowry, even as the market has fallen from its April highs, NDR has stayed firm in the conviction that the cyclical bull market continues unabated:
According to Dave Glen (CFA), who attended a recent meeting with NDR, here are the main points:
- NDR remains bullish on stocks and bearish on the outlook for bonds. Their favorite global sectors are found in the emerging markets, where they like the combination of strong growth and attractive valuations
- That said, they expect sluggish economic growth. Unemployment, unfortunately, is expected to remain high for a number of years to come due to a number of factors
- They are also not optimistic on the outlook for housing, since house prices and unemployment rates are inversely correlated
- Although they are not excited about the outlook for bonds, they are not abandoning the sector. They noted that with yields so low, and investor desire for safety still high, bonds could continue to at least hold their value. They continue to like corporate bonds, but are less excited about mortgage-backed securities. NDR does not have any strong views on the yield curve, noting that only the 30-year sector seems to offer value albeit with considerably more principal risk
- Within the US equity markets, their favorite sectors are consumer staples; industrials; and materials. They remain underweight health care and telecommunications.
The points above should be familiar if you’ve been paying attention to other well known strategists like Jeremy Grantham and James Montier. Specifically, Grantham’s reluctant allocation towards emerging markets (with the caveat that they could develop into bubbles within a few years) and his warning against bonds which are extremely expensive. This is also something that I’ve written about more than a few times: Why Today’s Bond Investors Will Be Disappointed.
As well, in his most recent commentary (The Paradox of Thrift) Montier mentions that he shares Grantham’s views on bonds.
Finally, NDR pointed out that this market is providing little opportunity for stock picking skills as the median correlation of stock returns is at an all time record high. According to Ned Davis Research, the median correlation for stocks is 0.82 - confirming the data from Birinyi Associates.
The causes of this peak in correlation are often cited as being due to the increasing use of structured products like ETFs (many with double, triple or even quadruple exposure), the non-participation of retail investors which has left the field occupied mainly by institutional investors, hedge funds and finally, quant firms that rely on high frequency trading strategies that buy and sell vast amounts of stocks in milliseconds.
But when you look through market history, it is obvious that there is a natural ebb and flow to correlation among stocks. At times they become a herd and at other times rugged individualists. I don’t think that the structural changes outlined above can fully explain what we are seeing. Rather, I suspect that it is a reflection of sentiment or “animal spirits” and as that changes, so will correlation revert to historical trend.
Source: The Herding Instinct Takes Over (WSJ)
Of course, portfolio managers hate to hear that correlation is so high because basically it means that they provide no value. That may be a bitter pill to swallow but keep in mind that this is temporary. But until this characteristic changes, this is a binary market. You are either in or out.
Personally, I’m still out because I’m not really seeing enough reasons for the market to power ahead. I’ve already outlined the details here: Continuing Weakness From Price & Breadth.
Looking at the S&P 500 index, it is continuing to meander. It did break above the downtrend line from the April 2010 highs but the 200 day moving average (blue line in above chart) is acting as resistance. As well, the market is struggling to put together a string of higher highs and higher lows. Until the market can prove itself, I’m happy to pay the opportunity cost of watching what could be the start of a strong rally up to the April highs and beyond.
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